The world is waking up – again – to the damage higher taxes do to growth

Tax was on the agenda like never before at last week’s Davos summit. It must mark the moment the UK changes course.

There was something in the water at Davos last week.

On Wednesday, the World Economic Forum hosted Argentinian President Javier Milei’s ode to free markets and individual liberty, the most staunch defence of those ideas from any world leader in living memory. By Thursday, Jeremy Hunt was evangelising the merits of tax cuts.

“I believe fundamentally that low-tax economies are more dynamic, more competitive and generate more money for public services,” said Hunt. On this occasion, he is right.

The UK’s overall tax burden is among the highest in peacetime history, hammering individuals, families, and businesses during a cost-of-living crisis, precisely when the UK economy needs a shot in the arm.

But the UK’s overall burden sits squarely inside the middle third of OECD countries. The more pressing concern for now is whether the tax burden is distributed well throughout the economy. As Fraser Institute research has shown, even countries with high overall tax burdens, like Sweden and Denmark, can remain prosperous keeping taxes on things like wealth and profits low. On this front, the Chancellor has a lot of work to do.

According to the 2023 International Tax Competitiveness Index 2023, the UK’s tax system is undermining its ability to compete with other nations and attract investment. Compared to the 2022 study, the UK fell three places to 30th, behind countries like Costa Rica, Greece, and Ireland. We would have fallen much further if not for our extensive network of international tax treaties.

By raising the headline rate of Corporation Tax last year, the Chancellor hiked one of the most damaging taxes, which also happens to be very inefficient in raising revenue. Empirical research has consistently found that the tax has a negative impact on growth, investment and entrepreneurship.

Corporate revenue raisers also do little to help the worst off in society. A 2014 literature review found that just under 58 per cent of the corporate tax burden is borne by workers in the form of lower wages and benefits. While full expensing for capital investment will blunt its negative effects, a cut in the headline rate of corporation tax or expanding the range of assets available for full expensing could be good first steps.

Corporation Tax also represents a broader problem in the UK’s system: complexity. The patchwork quilt of incentives creates economic distortions and increases compliance costs. The same is true of Inheritance Tax, Business Rates, and Income Tax – where political tinkering has created an effective 60% top tax rate on earnings between £100,000 and £140,000.

Nowhere is this more evident than VAT, where various populist demands for exemptions on certain products have created an absurdly complicated system. Unpopular as it might be, VAT is one of the most efficient and least distortive revenue raisers. But to maximise the benefits, rates should be fairly low, and the tax base needs to be large. Addressing this problem could give the Chancellor wiggle room to cut more damaging taxes like Income Tax and Stamp Duty – a significant drag on growth which compounds the misery of the UK’s broken housing market.

The Chancellor is right to say that countries with lower burdens tend to be more prosperous. Neighbouring countries like Estonia, Switzerland, and Czechia are ranked highly for tax competitiveness because of their low, well-designed, and simple taxes, a crucial ingredient to making them some of the select few European countries with good long-term growth prospects.

The final stage of grief is acceptance. Perhaps Jeremy Hunt’s comments at Davos will be a turning point after a lost decade-and-a-half of British economic growth.